Bank guarantees and the principle of autonomy

Lante Enterprises Limited v. Stella Ioannou and Hellenic Bank Public Company Ltd, Action No. 3575/2013, District Court of Larnaca, interim judgment dated 10 March 2014

Bank guarantees and the principle of autonomy — Assignment of a guarantee to a third party — The requirements of section 32 of the Courts of Justice Law — Non-disclosure of material facts and absence of urgency in an ex parte application

The facts

In 2006 the Plaintiff company sold to Defendant 1 a plot of land which was to emerge from a subdivision at the Voroklini Lake area of Larnaca, for a price of €86,355. To assist the purchaser in obtaining a loan from Bank of Cyprus to pay the purchase price, the vendor procured, through Hellenic Bank, a letter of guarantee in favour of Bank of Cyprus, guaranteeing the registration of the plot in the purchaser's name by a specified date.

The subdivision works were delayed and the plot was not transferred in time. In 2009, at the vendor's own request and with its consent, a new guarantee was issued, this time with the purchaser herself as beneficiary and for a substantially larger amount (CHF 226,600), reflecting the increased value of the plot. The purchaser assigned the guarantee to Hellenic Bank, with the vendor's express consent, and obtained from it a loan with which she repaid Bank of Cyprus. The guarantee was successively renewed, the final renewal expiring on 30.8.2013.

The plot had still not been transferred by that date. The purchaser terminated the sale agreement and, together with Hellenic Bank as assignee, demanded payment of the guarantee, which with interest amounted to €210,400. The vendor filed an action and obtained ex parte interim orders freezing the amount in the purchaser's accounts and prohibiting Hellenic Bank from paying out more than €128,000.

The legal issues

1. The principle of autonomy of bank guarantees. The Court reaffirmed, with extensive reference to the English authorities (R.D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd [1977] 2 All E.R. 862, Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] 1 All E.R. 976, Solo Industries UK Ltd v. Canara Bank [2001] EWCA Civ 1041), that bank guarantees constitute autonomous obligations, independent of the underlying contractual relationship. The courts will interfere with their machinery only in exceptional circumstances; banks must be left to honour their obligations on the basis of the documents, free from the commercial disputes of the parties. He who gives a bank guarantee takes the risk that goes with it.
2. The guarantee as an independent source of rights, beyond the contract. Of particular interest is the finding that the guarantee created new obligations on the vendor towards the purchaser, over and above those provided in the sale agreement: whereas the contract stipulated that transfer would take place upon the issue of separate title deeds, the guarantee rendered the amount payable simply upon the lapse of the specified date without registration. The fact that the guarantee was inconsistent with the contractual provisions did not affect its validity, its terms were clear, and the vendor, which had itself requested it and consented to its content, was not entitled to resile from it.
3. The consequences of the assignment of the guarantee. Decisive for the outcome was the distinction drawn as to the position of the assignee. The vendor did retain, as against the purchaser, a right to a "settling of accounts", in line with the principle in Cargill International SA v. Bangladesh Sugar and Food Industries Corp. [1998] 2 All E.R. 406, where it was held that, absent contrary provision, the beneficiary of a performance bond is ultimately entitled only to its true loss, any excess being repayable, but it retained no such right whatsoever as against the bank-assignee. By the assignment, to which the vendor expressly consented knowing that the bank would rely on it in extending the loan, the right to collect the full amount passed to the bank; the contractual disputes between vendor and purchaser do not touch the assignee. Consequently, no cause of action against the bank was demonstrated.
4. The requirements of section 32 and the proper targeting of interim relief. The Court recalled the three requirements of Odysseos v. Pieris Estates Ltd (1982) 1 C.L.R. 557 (a serious question to be tried, a visible probability of success, and difficulty or impossibility of doing complete justice at a later stage without the order) and observed that, even where the applicant anticipates an "accounting" after payment of a guarantee, the proper measure is not to obstruct the payment itself but, if anything, to freeze the sum received in the hands of the beneficiary, so that the dispute is detached from the guarantee and its machinery remains intact.
5. Non-disclosure of material facts and urgency. The judgment forcefully underlines the duties of an ex parte applicant. The vendor's affidavit concealed material facts, among them its express consent to the assignment and the demand made by Bank of Cyprus in 2009 which preceded the issue of the new guarantee, which of itself constituted a ground for discharging the orders (M & Ch. Mitsingas Trading Ltd v. The Timberland Co (1997) 1(C) C.L.R. 1791). Furthermore, the urgency invoked was held to be self-created: the vendor had long known when the guarantee expired and that a demand was certain, and could not rely on its own delay to justify the ex parte issue of the orders.

The outcome

The ex parte orders were discharged in their entirety, with the costs of the application awarded in favour of the Defendants, payable at the conclusion of the action, and with a separate set of costs for each Defendant. Defendant 1, in whose favour the orders were discharged, was represented by our firm.

Significance of the judgment

The judgment brings together, in a factual setting common in Cypriot property transactions, three (3) lessons of substantial practical importance.

First, it underlines the binding force and autonomy of bank guarantees: a party which gives a guarantee with clear payment terms cannot, once those terms are met, block its collection by invoking the provisions of, or disputes under, the underlying contract. Its protection lies after the event, through an action for its true loss, not in obstructing the banking machinery.

Secondly, it highlights the decisive effect of assignment: consent to the assignment of a guarantee to a bank which lends on the strength of it cuts off, as against the assignee, the "accounting" rights which the instructing party retains against the original beneficiary. This is a point which contracting parties, and in particular vendors of immovable property who provide guarantees pending the issue of title deeds, must weigh carefully before consenting.

Thirdly, it serves as a reminder of the strictness surrounding ex parte applications for interim orders: full and frank disclosure of all material facts is an inviolable duty, breach of which leads of itself to discharge, while urgency cannot be founded on a situation which the applicant itself created through its own acts or inaction.

This article is for informational purposes only and does not constitute legal advice. For specialised guidance on similar matters, please contact our firm.